How are EOTs different from traditional stock options?

Introduction to Stock Options

Stock options are a valuable compensation tool used by companies to reward their employees beyond cash remuneration. They offer the employees an opportunity to purchase the company’s shares at a fixed price. This fixed price is sometimes referred to as the ‘strike price’. The key principle behind employee shares is enabling employees to benefit from the company’s growth and success, creating a sense of ownership and further incentivising them.

However, in recent years, a new model of employee ownership has emerged as an alternative to traditional stock options. This is known as Employee Ownership Trusts (EOTs). An EOT is a special form of employee benefit trust involving a collective ownership structure that holds shares on behalf of the company’s workforce. The emergence of EOTs has spurred a debate regarding the pros and cons of EOT vs stock options.

Traditional Stock vs EOT Structure

Traditional employee share plans and EOTs both aim to offer employees a slice of the ownership pie, but they do so in different ways. Traditional equity options grant employees a right to purchase shares in the company at a set price. This might motivate the employees to work harder and drive the company’s growth. However, the employees would need to shell out their own money to exercise the options, and if the stock price falls below the strike price, the options become worthless.

On the other hand, EOTs are a democratically controlled company where the shares are held in trust. This means that the shares are purchased by the trust and held on behalf of all employees. EOTs provide all employees with an equal stake in the company along with an equal say in how the company is run. The key difference here in EOT vs stock options lies in true collective ownership with EOTs.

Benefits of EOT over Traditional Stock

One major benefit of EOTs is that they are intended to be long term, ensuring that the advantages of ownership are spread widely among employees. Furthermore, employees don’t have to finance the purchase of shares, as this is done by the trust. This is distinctly different from traditional equity options which require employee monetary investment, thus increasing the financial risk borne by employees.

Moreover, EOTs offer several tax advantages. For example, in the UK, sale of shares to an EOT is generally free from capital gains tax. Employees in EOT-owned companies can also receive income tax-free bonuses. In contrast, traditional stock options could trigger tax liabilities when the options are exercised and the shares sold.

Challenges & Considerations

While EOTs have numerous advantages, there are challenges and considerations that companies must bear in mind. The transition to employee ownership can be complex and time-consuming, requiring professional guidance. Plus, unlike traditional stocks, EOTs don’t provide an immediate financial advantage. Employees must wait for the company to make a profit and declare dividends before they receive any benefit.

Another key consideration is the element of risk. In a traditional equity plan, the risk is borne by the employees as they invest their own money. With EOTs, the risk is shared among all employees. While this collective risk might present a strong sense of unity, it might also lead to disagreements, particularly in tough business situations.

Real-world Comparison Examples

A practical comparison of stock comparisons can be observed in various companies around the world. Perhaps the most famous example of an EOT is the UK retailer John Lewis. All 85,500 permanent staff are partners who own the business and share in its profits. In contrast, tech giant Google’s employee stock options have turned many of its employees into millionaires, showing the potential for high reward in traditional equity if the company performs well.

Another example is Arup, a global firm of designers, engineers and business consultants, which has successfully run an EOT since 1977. On the other hand, Amazon’s stock options programme has received criticism for being too risky because it requires employees to own so much of their wealth in company stock, thus displaying the inherent risks of traditional equity.

Future Trends in Employee Stock Options vs EOTs

Recent trends suggest a growing interest in EOTs, particularly among small and medium-sized enterprises. This is due to factors like succession planning, cultural alignment, and the desire to share wealth more equitably among employees. EOTs can offer a practical solution for small to mid-size company owners looking to exit their business while ensuring its longevity and retaining its values.

However, traditional stock options are not being phased out. They remain prevalent, particularly among Silicon Valley tech companies that use stock options as a tool to attract and retain top talent. The future is likely to see both models coexisting, with companies choosing the model that best aligns with their needs, values, and circumstances.

Conclusion

In conclusion, EOTs and traditional equity both have their place in rewarding and motivating employees. The choice between EOT vs stock options boils down to a series of trade-offs. On one hand, EOTs offer long-term stability, spread the advantages of ownership widely and offer potential tax advantages. On the other hand, traditional equity can provide high rewards and direct alignment between individual effort and financial return. Ultimately, what works best is dependent on the specific context of the company and its employees.

What are stock options and how are they used as a compensation tool?

What is the difference between Employee Ownership Trusts (EOTs) and traditional stock options?

What are the benefits of EOTs over traditional stock options?

What challenges might businesses face with Employee Ownership Trusts (EOTs)?

What real-world examples exist of stock options and EOTs?

What are future trends in Employee Stock Options vs EOTs?